Central banks in 2026: our predictions for interest rate moves

There is a recognition within the Federal Reserve that even after 150bp of cumulative interest rate cuts, monetary policy remains modestly restrictive. However, officials’ relative position on the risks to the Fed’s dual mandate of price stability and maximum employment is becoming more dispersed.

Regarding the jobs story, it has been a low-hire, low-fire economy. This has resulted in payrolls growth stalling since the summer. Private surveys on hiring and lay-off intentions have been weak, and there have been high-profile job loss announcements from the likes of Amazon, Target, Paramount and UPS in recent weeks. The jobs mandate therefore argues for further rate cuts from the Fed.

However, inflation has proved to be sticky with tariffs and higher insurance costs potentially keeping it elevated, which explains why the hawks on the FOMC are reluctant to approve further policy easing. That said, tariffs are feeding more slowly into pricing than feared and this gives more time for disinflationary impulses from lower energy prices, weaker wage growth and slowing housing-related inflation to mitigate.

With the inflation backdrop looking less threatening but the jobs story becoming more fragile, the Fed is expected to lower policy rates to a more neutral setting of around 3.25% in 2026. The potential appointment of a more dovish Fed chair in May could tilt risks toward additional rate cuts.

The bar for yet another rate cut remains very high. While in the first half of 2025, large positive data surprises were needed to stop the ECB from cutting rates, currently we would need to see large negative surprises to push the ECB towards further rate cuts.

The ECB is seemingly happy with what it has often called ‘the good place’; a macro backdrop with inflation close to 2% and positive, though below potential, growth.

Given the many structural challenges of the eurozone economy, the ECB will maintain the well-known stance that there is very little monetary policy can do to tackle structural weaknesses. This is why we don’t see any ECB rate moves for the next two years in our base case. However, in the event of (projections of) significant inflation undershooting, one or two more rate cuts in the first half of 2026 should not entirely be excluded.

The committee is enormously divided. Four hawkish officials remain concerned that current levels of inflation (3.6%) will manifest into a more persistent bout of price pressure, akin to the post-2022 experience. The four doves, meanwhile, are more focused on the jobs market and the ongoing fall in wage growth. Governor Andrew Bailey sits between the two camps, though he has recently indicated he is minded to side with the doves at the December meeting.

We expect a cut before year-end. Headline inflation should fall in early 2026 and more dramatically from April. Food inflation appears to have peaked, too. As it becomes clearer that the UK is less of an outlier on inflation and as the upside risks ebb away, we expect two further cuts in the first half of 2026.

The Bank of Japan continued its slow and steady policy normalisation this year, raising policy rates by 25bp as of November and continuing quantitative tightening by offloading Japanese government bonds and ETF/JREITs from its balance sheet.

As we move into 2026, this gradual shift is expected to be maintained. Several board members have already expressed support for rate hikes, noting near 2% underlying inflation and negative real interest rates. Overall economic conditions have shifted as the BoJ anticipated, and new government policies are expected to assist the central bank in achieving its goals.

The new economic package will likely drive short-term growth and reduce headline inflation below 2%. Support for childcare, tax relief, and reduced energy costs is expected to encourage higher consumer spending and keep core inflation above 2%. We believe strong corporate earnings point to continued wage increases in the next spring wage negotiations. Rising government spending on defence and key strategic industries is also likely to stimulate further investment.

Continued inflation of around 2% combined with GDP growth above potential will underpin the BoJ’s policy rate hikes. Our base case projects the policy rate reaching 1.0% by the end of 2026. Nevertheless, if political considerations influence monetary decisions under the guise of policy coordination, the policy changes may proceed at a slower pace.

The PBoC was more cautious than expected in 2025, with only one major easing move in May to cut rates and the required reserve ratio for banks.

The limited easing can be attributed to three main reasons: first, the economy held up better than expected for much of the year, limiting the need for easing. Second, Chinese bank net interest margins continued to narrow, squeezing profitability, and further rate cuts could worsen the pressure on banks. And third, the equity market rally continued, prompting some to warn against fuelling a bubble.

We expect the PBoC to remain on an easing trajectory next year despite these factors, as the slowdown of the past few months shows that policy will need to remain supportive in order to secure another year of stable growth. We look for 20bp of rate cuts and 100bp of RRR cuts next year.